Toronto Construction Company is a family-operated business that was founded in 1950 by Albert Gat. In the beginning, the company consisted of Albert and three employees laying gas, water, and sewage pipelines as subcontractors. Currently, the company employs 25 to 30 people. Jack Gat is directing it. The main line of business continues to be laying pipeline.

Most of Torontos work comes from contracts which city and state agencies. All companys work is located in Toronto. The companys sales volume averages $3 million, and profits vary between 0 and 10 percent of sales.

Sales and profits have been somewhat below average for the past three years due to a recession and intense competition. Because of this competition, Jack Gat is constantly reviewing the prices that other companies bid for jobs; when a bid is lost, he makes every attempt to analyze the reasons for the differences between his bid and that of his competitors. He uses information to increase the competitiveness of future bids.

Jack has become convinced that Torontos current accounting system is deficient. Currently, all expenses are simply deducted from revenues to arrive at net income. No effort is made to distinguish among the cost of laying pipe, obtaining contracts, and administrating the company. Yet, all bids are based on the cost of laying pipe.

With these thoughts in mind, Jack began a careful review of the income statement for the previous year (see below). First, he noted that jobs were priced on the basis of equipment hours, with an average price of $165 per equipment hour. However, when it came to classifying and assigning costs, he decided that he needed some help. One thing that really puzzled him was how to classify his annual own salary of $114,000. About half of his time was spent in bidding and securing contracts, and the other half was spent in general administrative matters.

Gateway Construction

Income Statement

For the year ended December 31, 2007

Sales $3,003,000

Less expenses:

Utilities $24,000

Machin operators 218,000

Rent, office building 24,000

CPA fees 20,000

Other direct labor 265,700

Administrative salaries 114,000

Supervisory salaries 70,000

Pipe 1,401,340

Tires and fuel 418,600

Depreciation, equipment 198,000

Salaries of mechanics 50,000

Advertising 15,000

Total expenses 2,818,640

Income before income tax $ 184,360

Required:

1. Classify the costs in the income statement as (1) costs of laying pipe (production costs), (2) costs of securing contracts (selling cists), or (3) costs of general administration. For production costs, identify the prime cost, total manufacturing costs incurred, Cost of goods manufactured and Cost of goods sold. The company never has significant work in process (most jobs are started and completed within a day).
2. Using the functional classification developed in requirement 1, calculate the average cost per equipment hour for laying pipe.